BY JOHN ELLIS, FINANCIAL ADVISOR
When running a business it is vital to plan for events that could adversely affect its success. All companies insure against loss of profits from damage to its plant and machinery; against fire, theft public and employers liability. But so often neglect or lack the understanding as to the implications to a business of the sudden death or serious illness of a vital employee known as the ‘key person’.
To minimise the financial impact of losing key employees a business needs a Keyperson Insurance Plan to protect against the financial consequences of the death and/or serious illness of one of their key employees. The company pays the premiums and in the event of the death or serious illness of the keyperson, a cash sum is provided which will help maintain the business and protect its future security.
Areas that are impacted are loans on which the keyperson has given a personal guarantee – they may be called in. The keyperson’s estate may require the immediate repayment of personal loans made to the company. Credit facilities could be reduced or withdrawn due to the future profitability of the business. The loss of the individual’s expertise and business contacts with the consequent need to commit resources to find a suitable replacement which can be a prolonged process if the individual had unique experience and expertise.
Should a company decide to effect a keyperson plan there are a number of steps that need to be implemented.
The decision to effect a plan should be made and minuted at a board meeting of the company. This resolution should clearly show that the intention of the company in effecting the policy is to protect against financial losses in the event of the death or serious illness of the keyperson.
The company then needs to ascertain the amount required to protect against anticipated financial loss including the impact on profits with the loss of the Keyperson’s expertise. A Keyperson financial questionnaire will generally be required before the policy is effected.
There are various approaches to calculating this loss, for example, a multiple of net profits or a multiple of the Keyperson’s current annual salary. Also as outlined above, the cost of hiring a replacement should also be considered. The sum insured, required to cover any loans that the keyperson has made to the company, which will have to be repaid to his/her personal representative(s) and any company loans that the Keyperson has personally guaranteed, may have to be repaid, and should be considered.
The purpose of Keyperson Insurance is not to improve the financial situation of the company and increase its value. It is meant to indemnify against loss of profits on the death of a key individual.
Two important areas to note – an insurance provider will not accept a policy as a Keyperson case if the term runs past the normal retirement age of the employee or the terms of loans. The key-person has no substantial proprietary interest in the business and will have no entitlement to the proceeds, and so a ‘director cannot get the company to insure his life under a keyperson plan and use the proceeds for his personal needs. Therefore it’s imperative to seek independent professional advice in assessing these areas.
Assuming all the steps have been followed, a director of the company signs the application form ‘for and on behalf of the company’ – ideally, this should be a different person to the individual covered, but this does not have to be the case. The company’s seal should be affixed to the application form. The company pays the premiums and the Keyperson is on cover.
Regarding tax relief, according to the Revenue, the benefit paid under the policy is “treated as a trading receipt for the accounting period in which it is paid’. While the allowability of a premium or the chargeability of a benefit are strictly separate issues, it may be accepted that, if the premiums are allowable, the benefit is chargeable and, if the premiums are not allowable, the benefit is not chargeable
To claim tax relief the following conditions must be met. The relationship between policy owner and the life insured is that of employer and employee. The insurance policy covers loss of profits only. The policy is short-term, ie. the policy cannot extend beyond the employee’s likely period of service with the employer.